When last discussing Holly Energy Partners, L.P. (NYSE:HEP), the focus was upon the safety of their distributions given the tough times endured by their parent company, HollyFrontier, which has subsequently merged with Sinclair to form HF Sinclair (DINO), as my previous article discussed. Thankfully, their distributions were sustained as expected, thereby seeing their yield currently at a high 8.41%. These former tough times have since passed, with the refining industry enjoying booming operating conditions thus far into 2022 as the Russia-Ukraine war further tightens middle distillate supplies and economic activity recovers from the Covid-19 pandemic.
Since ten months have now elapsed, it seems timely to provide a refreshed analysis, especially following their parent company merging with Sinclair that also saw them acquire new assets, too, which excitingly, sees an even higher yield coming that could easily reach a very high 10%+ on current cost.
Since many readers are likely short on time, the table below provides a very brief executive summary and ratings for the primary criteria that were assessed. This Google Document provides a list of all my equivalent ratings as well as more information regarding my rating system. The following section provides a detailed analysis for those readers who are wishing to dig deeper into their situation.
*Instead of simply assessing distribution coverage through distributable cash flow, I prefer to utilize free cash flow since it provides the toughest criteria and also best captures the true impact upon their financial position.
Despite the severe economic turmoil seen throughout recent years on the back of the Covid-19 pandemic, their cash flow performance remained steady with only relatively insignificant fluctuations between 2019, 2020 and 2021. When looking at 2022, unsurprisingly, this continued into the new year despite their operating cash flow of $71.8m during the first quarter representing a decrease year-on-year versus their previous result of $82.1m during the first quarter of 2021 due to temporary working capital movements, which are normal for quarterly results. If these are removed, it sees their underlying operating cash flow for the first quarter of 2022 at $86.7m and thus slightly higher year-on-year versus their previous equivalent result of $82.5m during the first quarter of 2021, thereby continuing their steady cash flow performance.
Since they only completed their Sinclair acquisition on the 14th of March 2022, they essentially only saw two weeks of contributions before the first quarter ended. Thus, when looking ahead, their financial performance is poised to power ahead. When originally announcing this acquisition, they forecast that the newly acquired assets would provide circa $75m per annum of additional EBITDA at the midpoint, as per slide six of their August 2021 acquisition presentation. Since their EBITDA was $332.7m during 2021, as per their fourth quarter of 2021 results announcement, this should provide an approximate 20% boost to their EBITDA and, by extension, to their operating cash flow, since both should broadly move in tandem given their positive correlations.
Since there has been little discussion regarding the additional capital expenditure that their new Sinclair assets will require, it seems reasonable to scale their free cash flow higher by approximately 20% as well, thereby increasing their average of $240.1m during 2019-2021 to an estimated circa $290m per annum going forwards. Meanwhile, the equity funding portion of this acquisition saw their latest outstanding unit count expand to 126,440,201, which means that their quarterly distributions of $0.35 per unit will now cost $177m per annum. When combined, this points towards strong distribution coverage of around 160% that not only leaves their existing high 8%+ yield safe and sustainable, but also capable of funding growth, which could easily see their yield increase to a very high 10%+ on current cost in the coming years providing that their financial position remains healthy.
Apart from issuing new units, their Sinclair acquisition also saw a cash payment of $321.4m that reversed their steady deleveraging throughout 2020 and 2021 to now see their net debt land at $1.619b. This is 22.80% higher than the $1.319b they saw at the end of 2021. When looking ahead into the remainder of 2022 and beyond, their net debt should once again begin steadily decreasing, given their outlook to produce excess free cash flow after distribution payments.
It was not surprising to see their higher net debt push their leverage higher, especially since the additional earnings of their Sinclair assets are yet to flow through to their financial statements to any material extent. This saw their respective net debt-to-EBITDA and net debt-to-operating cash flow increasing to 5.27 and 4.67, respectively, which, in the case of the former, now resides above the threshold of 5.01 for the very high territory.
Whilst this would not be ideal, thankfully the additional earnings from their acquisition will push this lower during the coming quarters and thus, given the forecast circa 20% increase to their EBITDA, it should offset the circa 20% increase seen to their net debt and thus once again push their net debt-to-EBITDA back below the threshold for the very high territory. Even though this would still see high leverage, it does not necessarily pose any significant concerns for the safety of their distributions given the steady and resilient nature of their cash flow performance.
Thankfully their liquidity remains strong even after funding their Sinclair acquisition, with a current ratio of 2.03 and a cash ratio of 0.35. Although their credit facility was utilized to fund this acquisition and, as a result, it only had a relatively minor $58.5m left available at the end of the first quarter of 2022. This should be rectified following the second quarter after their $400m senior notes issuance in April, which do not mature until 2027 and should effectively refinance a portion of their credit facility.
Thankfully their credit facility does not mature until 2025, which provides breathing room to refinance and repay its remaining balance with their existing $500m senior notes that form the other part of their debt structure also not maturing until 2027, as the table included below displays.
It can sometimes be risky for income investors when a partnership makes a sizeable acquisition, as they could be left either overleveraged or burdened with too high of an outstanding unit count to be capable of safely funding their distributions. Thankfully neither are the case in this situation given the outlook for strong distribution coverage and a reasonably healthy financial position making room for further distribution growth.
Realistically, I suspect they are likely to keep their distributions static during the remainder of 2022 whilst they integrate their newly acquired Sinclair assets. Given the prospects to continue collecting a safe and sustainable high distribution yield that has room to grow into a very high 10%+ yield on current cost in the future, I believe that maintaining my buy rating is appropriate.
Notes: Unless specified otherwise, all figures in this article were taken from Holly Energy Partners' SEC filings, all calculated figures were performed by the author.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.